Many people don’t realize that Lewis Carroll (the Reverend Charles Ludwig Dodgson) wrote Alice in Wonderland as an allegory about mathematics. At present, the stock market is once again in one of those moods where it might as well be one of the good parson’s stories. It is “through the looking glass”—where black is white and white is black.
For months, analysts and investors alike have lamented the “jobless” recovery. All of a sudden, the cosmos appears to be in order. Stronger purchasing activity depleted inventories, and more overtime persisted until a hiring binge was finally unleashed. During each of the past two months, the US economy has added about 300,000 jobs. The market should be really excited. Right?? Wrong!!
We are now entering one of those quirky times when good news is bad news and bad news is good news. It’s happened before. During the time I’ve been practicing the dismal science and losing my hair, I have seen and chronicled several such periods. No sooner does the economy get cranked up than folks start to worry about interest rates going up. As the Federal Reserve held its recent policy meeting, many of the obsessive market watchers were hoping interest rates would be raised and almost begged for it. The decision was made to keep them steady for now, but “guidance” was given that rates would be going up soon. After thinking about it over the weekend, the same pundits decided maybe they didn’t want that after all, thus sending the Dow Jones Index into triple-digit decline.
These are conditioned responses—not unlike Pavlov’s dogs. When growth is sluggish, they want more. When they get more, it’s too much. Thus, we are about to see an extended period in which every piece of good news about the economy will be greeted with horror by the investment community. Never mind that long-term economic growth is the best, indeed, the only way to assure that most firms can achieve the sustainable and increasing profitability that drives stock prices upward.
The process begins when the Mad Hatters in Washington tell Alice and her fellow investors that orders are flourishing, production is soaring, and jobs are being created at a brisk pace. All is right with the world. The response is “Oh! No! Interest rates are going up! Sell! Sell! Sell!” The market responds accordingly, and billions in paper wealth vanish in the wake of positive news.
Weird? Yeah. The Federal Reserve tries to use interest rate policy to achieve a delicate balance between growth and inflation. In recent history, it has probably erred on the side of overzealous protection against rising prices (interest rate policy is not especially well suited for that purpose in any case, but that’s a subject for a different day). Thus, at the first sign of a booming economy, we tend to fight a war against inflation that doesn’t really exist. Our last downturn was worse than it needed to be due to excessive rate increases during the upswing.
The bottom line is that we have entered a new era in which productivity gains derived from globalization, technology, and a very well-trained workforce permit extended expansions without inflation. The only signs of inflation at present stem from higher petroleum prices. The last time I checked, those weren’t much influenced by wiggling US interest rates. Nonetheless, it is likely going to take a couple of additional cycles before the powers that be figure this one out. So, like it or not, interest rates will be going up in the next few months. Even in Wonderland, conventional wisdom can be quite stubborn, and we must once again view our economic well-being through the looking glass.